Zambia's central bank cut its policy rate for the first time in more than two years to prevent a further deterioration in the economy that is already projected to shrink for the first time in more than 20 years.

The Bank of Zambia (BOZ) cut its policy rate by 225 basis points to 9.25 percent, the lowest level since May 2013 when the central bank was in the midst of a tightening campaign that began in October 2012 and first ended in November 2015 when the rate topped out at 15.50 percent.

From February 2017 BOZ then began easing and cut its rate by 575 basis points to 9.75 percent during the next year, with the final cut taking place in February 2018.

The rate was then maintained until May 2019 when BOZ had to return to the tightening path due to accelerating inflation from the depreciating exchange rate and raised its rate twice to 11.50 percent by November that year.

The rate comes comes against a backdrop of a continued acceleration in inflation due to higher fuel pump prices, electricity tariffs, food prices and a pass-through of the depreciation in the kwacha.

And although the projected path for inflation is higher than BOZ forecast in February, it said inflation will trend towards the upper bound of its 6-8 percent target range.

This upward pressure on inflation is expected to come from persistently high fiscal deficits, rising external debt service payments, accumulation of domestic arrears, high production costs, and dampened copper prices and exports earnings from a weak global economy.

But improvements in maize output and subdued domestic demand from the COVID-19 pandemic could result in inflation falling faster than expected, BOZ added.

Zambia's inflation rate rose to 15.7 percent in April from 14 percent in March, mainly from the lower exchange rate of the kwacha.

Zambia's kwacha has been weakening since September 2018 but the pace accelerated sharply following the outbreak of the coronavirus, compounding existing concern over the country's high debt service and debt levels.

Last month Zambia's finance ministry was reported to have contacted banks regarding restructuring of up to $11.2 billion of foreign debt.

With the pandemic set to boost fiscal deficits and drain international reserves, the kwacha fell almost 17 percent during March.

But since early April the kwacha has firmed and was trading at 18.2 to the U.S. dollar today, down 23 percent this year. To ease some of the pressure on the kwacha, BOZ has provided support, it said.

Fiscal pressures are expected to heighten this year, with BOZ projecting a 14.8 billion kwacha decline in revenue along with the higher cost of servicing debt from a lower kwacha.

"The fiscal deficit in 2020 is bound to exceed the 5.5% budget target," BOZ said, adding gross international reserves had declined to US$1.393 billion at the end of March from US$1.449 billion at the end of December due to debt service payments.

"With the COVID-19 pandemic, the already challenged domestic macroeconomic environment has worsened," BOZ said, forecasting a contraction of 2.6 percent this year following growth of 1.9 percent in 2019 for the first contraction in gross domestic product in more than 20 years.

The central bank's latest survey of businesses opinion and expectations indicated that economic conditions had worsened in the first quarter, with the volume of services, new orders and profitability all registering historic lows, BOZ said, adding the purchasing managers' index also showed a sharp decline in new orders and output amid falling consumer spending and company shutdowns.

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